How to Invest in Technology As Regulators Defang Giants

US state attorneys general recently stepped up their scrutiny of big tech’s business practices. With corporate mammoths likely to be in the crosshairs of regulators for some time, equity investors should consider looking beyond the titans for opportunities in the sector.

The battlefronts for big tech are multiplying: in addition to state attorney generals, the US Department of Justice, the House Judiciary Committee and the Federal Trade Commission are all pursuing inquiries. Corporate policies on competition, privacy and data sharing are under the microscope. Investors face more uncertainty if, beyond potential fines, new regulations threaten corporate business models or force the breakup of some companies. Restricting the ability of these companies to leverage user data across multiple platforms could deal a painful blow to their main business advantage.

Facing the FAANGover from Regulation

The answers to these concerns will come only at the end of a years-long process. Government agencies are like a black box for equity analysts, making it hard to get reliable information about where the process is headed. Regulatory uncertainty helps explain some of the recent volatility in big tech stocks and is likely to cloud the outlook for the foreseeable future.

So, what to do? Given the uncertainty, we believe investors seeking to capitalize on the promise of technological growth should be wary of passive exchange-traded funds, whose baseline benchmark indices tend to be heavily weighted with tech giants and are backward-looking (Display).

Instead, investors need to take a proactive approach to the technology sector. Many investors have relied on Facebook, Amazon, Apple, Netflix and Google—the FAANGs—to capture technology-driven growth. But we believe that there are many compelling trends and companies in technology with potential to generate alpha, and with less regulatory risk than some of the larger players. Opportunities can be found not only in technology hubs like Silicon Valley, but around the world as well.